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Saturday, June 19, 2021

Oil funds and managing the macroeconomic effects for Guyana

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Bobby Gossai, Jr.
Bobby Gossai, Jr. is currently pursuing the Degree of Doctor of Philosophy in Economics at the University of Aberdeen with a research focus on Fiscal Policies and Regulations for an Emerging Petroleum Producing Country. He completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the same institution, and also holds an MSC in Economics from the University of the West Indies. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association and senior policy analyst and advisor at the Ministry of Natural Resources and Environment.

Successive Guyanese governments will have to consider the concept of a separate oil fund. A separate fund could entail providing for a fixed sum to be spent in areas additional to the government’s main spending programmes. However, it may be argued that in many cases there would be overlap. Expenditure from the fund would have a lower priority than that under the government’s programmes and, if there are one set of priorities for fund revenues and another for government programmes, there would be the risk of confusion. It can also be argued that there may be no obvious way of identifying what public expenditure are set to really be made possible by the offshore revenues.

There is the distinct possibility of fungibility of spending: a new hospital could be presented as being paid for from the fund, but it could be built anyway from other government funds. Implicit in the above is the basic idea that a proposed project should be accepted or rejected on its intrinsic merits rather than on the origin of the funds which finance it.

These arguments are not fool-proof. Without a separate oil fund there is a danger that consumption facilitated by oil revenues will exceed the permanent level, particularly if there is significant myopia among consumers. Governments may have a strong temptation to employ all of the Guyana Offshore Basin revenues not as a special revenue source to facilitate extra investment, but as a device which would enable other taxes to be reduced. Further, these other taxes might well be reduced in such a way as to increase consumption rather than investment. Guyana’s offshore revenues could be employed as a relatively painless source of funds to finance ongoing, “normal” government programmes, and as a device to avoid politically unpopular decisions to raise other conventional taxes. The end result could then be that investment will be less than the desired level from the viewpoint of the optimal intergenerational use of oil revenues.

It is on such grounds that the argument for a years-on separate oil fund can be made. The offshore basin revenues will be different from other sources of revenue because they emanate from the depletion of a particular non-renewable natural resource. Guyana’s petroleum resources are part of the nation’s capital stock, and its depletion directly raises the question of the renewal of the total capital stock. It is important that the investible revenues be directed where they are expected to earn the highest returns (defined in a wide sense). Thus, overseas investment should be included in the possibilities open to the fund. The government should not have direct access to the fund: its “normal” obligations should remain.

The case for an oil fund is certainly not watertight. If other mechanisms could ensure that the appropriate share of oil revenue was invested rather than consumed, it would not be necessary. While not conclusive, there is evidence that this may not happen in an entirely free market situation. The mechanism of an independent fund could ensure that Guyana’s Offshore Basin revenues are invested without leaving the pattern of investment under government control. Guyana’s offshore fiscal revenues may, of course, decline enormously if there is a collapse in oil prices. An oil fund would not have such large resources to manage in future years (unless oil prices increase very dramatically). Fundamentally the key issue is not the desirability or otherwise of an oil fund, but a mechanism which ensures that the appropriate share of the revenues is invested rather than consumed.

The idea that oil is a “curse” is only partly true. Oil is, of course, an enormously valuable resource that can bring economic benefits to an economy. Oil-rich states have often outperformed their neighbours that lack oil. Generally, oil-rich countries, region by region, tend to have higher per capita income levels (in purchasing power terms). This often corresponds to higher levels of private consumption as well. In many other categories of well-being – life expectancies, child mortality rates, electricity use per capita, paved roads, etc. – oil producers are better off than their oilpoor counterparts. Sometimes the gap is statistically significant, though often not. There is no generalised tendency, to be sure, for oil-rich countries to perform economically less well than oil-poor counterparts in terms of levels of economic performance (Humphreys, Sachs, Stiglitz 2007).

The “curse” is real, however, in one important sense: economic performance of oil economies has fallen far short of potential, and sometimes disastrously so. Oil earnings have rarely lived up to the plausible expectation that they should be a stimulus to long-term, economic development (Sachs and Warner 2001). The curse – that oil earnings often do not translate into long-term development – is not a matter of fate, however. Oil can be a springboard to development.

Despite the volatile history, oil in principle should be able to offer three huge benefits for an emerging oil-producing state such as Guyana:

  • First, the oil income itself can boost real living standards by financing higher levels of public and private consumption. This has typically been the case.
  • Second, oil can finance higher levels of investment, both out of oil income itself and out of borrowing made possible by the oil income.
  • Third, since the oil income typically accrues largely to the public sector, and indeed to the public budget, the oil can obviate one huge barrier to development: the lack of fiscal resources needed to finance core public goods, including infrastructure. The point, of course, is that oil is not only part of national income but also of fiscal income, with the potential advantage of financing public investments that are inevitably a key part of any coherent development strategy.

The scarring point of managing oil, therefore, is taking a long-term view of national development. While volumes can and have been written on appropriate development strategies, and while circumstances necessarily differ across countries, some general principles are helpful.

  • First, development depends on a mixed economy, in which both public and private investments contribute to economic growth.

Public investments are needed to finance two kinds of goods: public and merit. Public goods are goods that are underprovided by the private sector in a market economy, generally because the goods are nonrival or nonexcludable or both. Public goods include national defence, the rule of law, environmental protection, scientific research, infectious disease control, and basic infrastructure networks (roads, power, urban water, and sanitation). Even when some of these goods are technically excludable (e.g., access to roads can be rationed by toll booths or permits for use), it is often very inefficient to exclude potential users because marginal costs of new users are low. Merit goods are goods that on principle should be available for everyone in the society for the sake of social harmony and justice. Merit goods include basic health care, basic education, social insurance for unemployment and disability, safe drinking water and sanitation, adequate basic nutrition, and safe shelter. The provision of merit goods to the poorest members of society has spill over benefits for the entire society in the form of enhanced political and social stability.

  • Second, public investments should be based on a sound macroeconomic strategy, meaning a budgetary framework that preserves both short-run macroeconomic stability and long-term fiscal solvency.

Macroeconomic stability entails overall price stability, and the absence of abrupt cuts into spending that result from a sudden worsening of credit terms. Fiscal solvency, of course, means the management of the public sector to maintain the ability to service public debts without crisis. The investment framework should take account of the inherent instability of oil earnings on a year-to-year basis, and the eventual depletion of oil reserves. Both because of the volatility and depletion, it is useful to distinguish a “sustained” or “permanent” level of oil income flow as distinct from the oil earnings in any particular year. Based on the long-term profile of oil income, a sound public investment profile should be adopted for incorporation into annual and medium-term budgetary framework.

  • Third, public investment spending should be seen as a complement rather than a substitute for private investment spending.

In practice, this means achieving a clear understanding of the respective roles of the public and private sectors in the economy. Public investments should be focused on public goods and merit goods, leaving the private sector free to build private-owned economy alongside the public investments. The major public sector investments come down to infrastructure, health, education, social security, and knowledge creation (especially basic science). Private sector investments focus on the rest of the economy: agriculture, mining, manufacturing and nonstate services.

  • Fourth, the public investment spending should be part of a development strategy with a timeframe of a decade or more, since many public investments have long lead times.

The Sustainable Development Goals (SDGs) provide an enormously useful framework for such a development strategy, because the SDGs set bold but achievable poverty reduction goals that have been endorsed by all of the world’s government. The SDGs, therefore, offers a practical advantage to emerging economies such as Guyana. Of course, “stretch goals” raise special challenges. If public investment projects are scaled up too quickly, inefficiencies are bound to multiply because of limited absorptive capacity in the domestic economy. For example, increased physical investments in health, agriculture and oil field services (e.g. clinics, irrigation systems and supply bases) are far more effective when they are combined with multiyear training programs for workers in those sectors, to avoid skill shortages and other bottlenecks. The SDGs are achievable in all parts of the economy, but it will require sophisticated intersectoral planning on a decade-long timetable to do so.

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